US embassy cable - 05ANKARA7210

UNCLAS SECTION 01 OF 02 ANKARA 007210 
 
SIPDIS 
 
TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER 
NSC FOR MERKEL AND MCKIBBEN 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN, TU 
SUBJECT: Killing Off Inflation - Move to Formal Inflation 
Targeting 
 
 
1. (SBU) Summary: The Turkish Central Bank announced that it 
will begin formal inflation targeting in 2006, and announced 
a targeted inflation rate of 5% in 2006, and 4% each in 2007 
and 2008.  This marks another milestone in Turkey's quest 
for economic normalcy.   Although not without risk, the move 
to formal inflation targeting represents another important 
nail in the coffin of Turkey's history of high inflation. 
End Summary. 
 
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Serdengecti Announces Formal IT 
------------------------------- 
 
2. (SBU) In a December 5 press conference, Central Bank 
Governor Sureyya Serdengecti announced details of the Bank's 
monetary policy for 2006, including the long-expected change 
to formal inflation targeting (IT), also called explicit 
inflation targeting.  Although the Turkish Central Bank 
(CBRT) has been informally targeting an inflation rate as 
its primary indicator, until now the Bank has had some 
flexibility to consider other factors in setting monetary 
policy. 
 
3. (SBU) The new system locks in explicit targeting of 
inflation as measured by change in the Consumer Price Index 
(CPI), changes the monetary policy committee from an 
advisory to a policy-setting role and lays out a more 
formalized and transparent policy-setting mechanism.  The 
Central Bank has long been preparing for the move to formal 
IT, because of its successful track record in a growing 
number of countries and in keeping with IMF recommendations. 
 
--------------------------------------------- ---------- 
Move to IT Key Step on Turkey's Road to Price Stability 
--------------------------------------------- ---------- 
 
4. (SBU) The CBRT's announcement is a powerful manifestation 
of the progress it has made, under Serdengecti's skillful 
leadership, in bringing down inflation.  2004 was the first 
year since the early 1970's in which Turkey's inflation rate 
was in single digits, with rates sometimes over 100% during 
the worst years of the 1990's.  In four short years since 
the 2001 crisis, the CBRT's tight monetary policy, helped 
along by the GOT's  tight fiscal policy, favorable global 
conditions, a strong lira and increased political stability, 
has enabled a gradual disinflation.  For 2005, Turkey is on 
track to register CPI inflation slightly below the 8% target 
for the year. 
 
5. (SBU) Serdengecti has long told us privately that he 
could only move to formal IT once he was confident the 
disinflation process was well-entrenched: if inflation 
spiked under formal IT the CBRT could lose credibility and 
have few good policy options.  Clearly, Serdengecti now 
feels sufficient confident to move to formal IT.  The 
lowering of inflation expectations, the Government's track 
record of fiscal austerity-including tightening fiscal 
policy in 2006-and the gradual build up in the Bank's 
inflation-fighting credibility have enabled the Governor to 
take the plunge into formal IT. 
 
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Wiggle Room from the "Uncertainty Band"? 
---------------------------------------- 
 
6. (SBU) Indeed, perhaps because he fears being locked into 
a rigid target with no room for maneuver, Serdengecti 
accompanied the announcement of inflation targets (5% in 
2006 and 4% each for 2007 and 2008) and an "uncertainty 
band" of 2% in below and above the target in 2006, with 
subsequent years' bands to be announced later.  Serdengecti 
denied the band means the Bank is targeting a range, and 
said the Bank would be accountable to explain deviations 
from the target.  At the same time, he explained that 
setting a band recognizes the large number of factors 
outside the Bank's control, such as a spike in oil prices or 
other external shock.  Perhaps to counter accusations that 
the Bank was targeting a path, Serdengecti also charted a 
quaterly "path" for inflation: 7.4% as of March, 2006,  6.5% 
in June, 5.8% in September and 5% by yearend 2006. 
 
---------------------------- 
Reserve Build-up to Continue 
---------------------------- 
 
7. (SBU) Serdengecti also announced that the Central Bank's 
program of Foreign Exchange purchase auctions would 
continue, with an increase in the daily purchases from $15 
million to $20 million, with optional additional purchases 
of $40 million instead of $30 million.  These increases 
reflect the Bank's agreement with the IMF on the 
desirability of continuing to take advantage of favorable 
market conditions to build foreign exchange reserves. 
Although, the Bank keeps increasing its reserves, the ratio 
of reserves to short-term debt remains low by international 
standards. 
 
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The Challenge in Meeting the 2006 Target 
---------------------------------------- 
 
8. (SBU) Despite the Bank's impressive track record in 
recent years, many analysts believe the 5% 2006 inflation 
target may be difficult to achieve.  Risks abound: higher 
oil prices, the potential for erosion of GOT fiscal 
discipline as elections draw near, ongoing price rigidity in 
the services sector--all could threaten achievement of the 
target.  CSFB for example, is forecasting 2006 inflation of 
6.2%. 
 
----------------------------- 
 Who Comes After Serdengecti? 
----------------------------- 
9. (SBU) One risk cited by analysts which is increasingly 
discussed in the local press is what will happen after 
Serdengecti's term expires in March, 2006.  Though the GOT 
could reappoint him-and this would be the lowest-risk option 
vis--vis potential market volatility-the betting is that 
the GOT will replace Serdengecti.  If the AKP Government's 
track record holds true, they will select someone with 
closer ties to the Government, but will most likely choose 
amongst figures who would not upset the market.  Serdengecti 
himself has told us he just privately he just wishes the 
Prime Minister would make a decision, well before the end of 
his term, so as to allow him to prepare for the transition 
if he is not reappointed. 
 
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Comment 
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10. (SBU) The announcement of formal IT is an important 
stepping stone to price stability in Turkey, a key nail in 
the coffin of Turkey's bad old days of high inflation. 
Serdengecti deserves tremendous credit for what he has 
accomplished.  Risks associated with the end of his term and 
other pressures will mean an extra challenging year ahead 
for meeting the target. 
 
Wilson